CFA Institute CFA Institute Certifications CFA-LEVEL-1 Questions & Answers

• Question 281:

  A preferred stock has a dividend payout of $5 every 6 months. Your required rate of return is 20% annually. What is the value of the preferred stock?

  A. $99

  B. none of these answers

  C. $75

  D. $50

  Correct Answer: D

  First recognize that the appropriate discount rate to use is half of 20% or 10% because the dividend is paid out twice a year. Next calculate the value of the stock as Dividend/Required rate or $5/0.1 = $50.

• Question 282:

  The P/E ratio is determined by the expected ________ and by k and g.

  A. dividend payout ratio

  B. stock ratio

  C. earnings ratio

  D. g/k ratio

  Correct Answer: A

  The price/earnings ratio can be computed by dividing the expected dividend payout ratio (dividends divided by earnings) by the required rate of return (k) minus the expected growth rate of dividends (g).

• Question 283:

  An independent financial analyst has been investigating shares of Viirius Wavelength, a small fiber optics firm, for possible investment. This financial analyst has a history of value investing, and believes that shares of Viirius are not reflecting their "intrinsic value." In her analysis, this financial analyst has assimilated the following information for Viirius Wavelength:

  Net Worth: $2,000,000 Number of common shares outstanding: 8,900,000 Current stock price: $11.63 per share Earnings per share: $0.16

  Using this information, what is the price-to-book ratio for Viirius Wavelength? Further, what is the price-toearnings ratio using trailing earnings figures?

  A. 51.75, (72.69)

  B. 0.225, 72.69

  C. The answer cannot be calculated from the information provided.

  D. None of these answers is correct.

  E. 0.225, (72.69)

  F. 51.75, 72.69

  Correct Answer: F

  The book value of a common stock is found by dividing the net worth of a company by the number of

  outstanding shares. While there exists several different methods for calculating net worth, the most

  simplistic involves subtracting total liabilities from total assets, giving us the shareholder's equity figure.

  The book value is often seen by investment professionals as a "floor" for common stock prices, and the

  price-to-book ratio is quite popular in the field of investment management. The calculation of the price-tobook ratio involves the following equation:

  Price-to-book ratio = {P0 / (Net worth / # of common shares outstanding)}

  In this example, all of the necessary information has been provided. Imputing these figures into the pricetobook value equation will yield the following:

  Price-to-book value = {$11.63 / ($2,000,000 / 8,900,000)} = 51.75.

  Any time the price-to-book ratio is greater than one, a stock is said to be "trading at a premium to book."

  Frequently, investment professionals will use the term "intrinsic value" when referring to the book value, as

  illustrated in this example. A figure of less than one for the price-to-book ratio is commonly referred to as

  "trading at a discount to book." Stocks trading below book value are often sought after by value investors,

  who believe the shares have been discounted below their liquidation value. While the price-to-book value

  is a useful tool in the stock selection process, it possesses some important flaws. One problem with the

  Price-To-Book Ratio is that one of the terms - Book Value - is so easily manipulated. Valuation of inventory

  and real estate are easily adjusted on the books. Stock buy-backs and write-offs of exceptional items also

  deflate Book Value, making high priced stocks seem overvalued.

  Since trailing numbers are to be used (i.e. earnings figures which have already been realized), the

  calculation of the price-to-earnings ratio is simple in this case - simply divide the market price by the EPS

  figure, which leads to a P/E of 72.69 for Viirius Wavelength.

• Question 284:

  Which of the following is not required to determine the value of a stock that is to be held for one year?

  A. required rate of return

  B. expected sale price

  C. original purchase price

  D. dividends

  Correct Answer: C

  A stock that is held for one year earns the investor some dividend and will be sold after one year for some capital gain. Both the expected sale price and the dividend payout during the one-year holding period need to be discounted to reflect the present value of the stock.

• Question 285:

  Which of the following will lead to a decrease in the price of a stock, all else equal?

  I. An increase in the systematic risk of the stock.

  II. An increase in the total variance of the stock.

  III. A decrease in its covariance with the market.

  IV.

  An increase in the growth rate of its dividends.

  A.

  II only

  B.

  I only

  C.

  IV only

  D.

  III only

  E.

  I and III

  Correct Answer: B

  An increase in the stock's expected rate of return decreases the price of the stock. This will happen if the stock's systematic risk increases so I is a correct choice. Note that the systematic risk decreases when the security's covariance with the market decreases. Hence, III is excluded.

  An increase in the variance of the stock does not necessarily change its expected return. Only if the systematic component of the stock's variance changes will the expected return change, causing a price change. Therefore II is not a correct choice.

  Finally, an increase in the growth rate of dividends will increase the stock price, so IV is also not a correct choice.

• Question 286:

  The asset allocation for a country within a ________ portfolio will be affected by its economic outlook; countries approaching a recession will be ________.

  A. local; overweighted

  B. global; underweighted

  C. local; underweighted

  D. global; overweighted

  Correct Answer: B

  Monetary and fiscal policies enacted by national governments influence the countries' aggregate economies, which, in turn, influence all industries and companies within the economies. Some examples are government spending's multiplier effect and the raising of firms' costs due to restrictive monetary policies. Taking a global perspective, the asset allocation for a country within a global portfolio will be affected by its economic outlook - countries approaching a recession will be underweighted, while optimistic economic outlooks would cause an investor to overweight the country.

• Question 287:

  A block uptick-downtick ratio of 0.67 would be viewed by technical analysts as

  A. a neutral sign.

  B. a bearish sign.

  C. a bullish sign.

  D. a sign that the market is oversold.

  E. a sign that the market is overbought.

  Correct Answer: B

  A block uptick-downtick ratio is equal to the number of upticks for block trades divided by the number of downticks for block trades in a given period. Upticks are assumed to be initiated by buyers, while downticks are assumed to be initiated by sellers. Technicians view a low ratio value (0.70 for example) as a sign of heavy selling and a bearish sentiment on the market. In contrast, they view a high ratio value (1.2 for example) as a sign of heavy buying and a bullish sentiment on the market.

• Question 288:

  The price range at which a technician would expect a substantial increase in the supply of a stock is

  A. the incentive price.

  B. the trough price.

  C. the support level.

  D. the resistance level.

  Correct Answer: D

  Incentive price is not a real term. Technicians believe that after a stock has fallen from some previous higher price level, investors who bought at that higher level will wait for the price to come back up again to unload the stock at their break- even level. When the stock does reach that price range, selling by those investors will cause a substantial increase in supply.

• Question 289:

  Given that the expected dividend payout ratio on a common stock is 0.55, the required rate of return is 17%, the dividend growth rate is 12%, and next year's earnings are $2.52, using the earnings multiplier model, what is the estimated value of the stock?

  A. $23.95

  B. $30.88

  C. Not enough information

  D. $25.52

  E. $27.72

  Correct Answer: E

  The earnings multiplier model postulates that P/E = (D1/E)/(k -g), where P/E is the price to earnings ratio, D1 is next year's expected dividends, E is next year's earnings, k is the required rate of return, and g is the growth rate in dividends. D1/ E is also known as the dividend payout ratio. In this question, the P/E is 0.55 /

  (0.17 - 0.12) = 11. We can multiply P/E by next year's earnings to arrive at our expected current stock value ((P/E) x E = P). In this question, the estimated value is 11 x 2.52 = $27.72.

• Question 290:

  A financial analyst is examining the performance of Intelligent Semiconductor, a diversified technology company, and has assimilated the following information for the most recent fiscal year:

  Adjusted operating profit before tax: $12,675,000 Cash operating taxes: $4,240,000 Cost of capital: 16% per year Total capital employed: $60,700,000

  Using this information, what is the economic value added for Intelligent Semiconductor? Further, should the management of Intelligent be considered to have provided appropriate economic value for shareholders?

  A. $1,633,620; management has not created economic value

  B. $1,633,620; management has created economic value

  C. None of these answers is correct.

  D. ($1,227,000), management has not created economic value

  E. ($497,000), management has created economic value

  F. $735,000; management has not created economic value

  G. $1,227,000; management has created economic value

  Correct Answer: D

  Economic Value Added, a value-based measure of economic profit, is a registered trademark of Stern,

  Stewart and Company. The equation used to calculate EVA is as follows:

  EVA = {Net Operating Profits Less Adjusted Taxes - [Total Capital Employed * (Cost of Capital)]}.

  In this case, the NOPLAT figure must be calculated manually by subtracting the Cash Operating Taxes

  from the Adjusted Operating Profit before Tax (AOPBT) figure. Doing so will produce an answer of

  $8,435,000 for the Net Operating Profit less Adjusted Taxes figure. Now that the necessary information

  has been determined, the calculation of EVA is as follows:

  EVA = {$8,435,000 - ($60,700,000 * 0.16)} = ($1,227,000)

  A negative EVA calculation indicates that management has failed to provide economic profits to

  shareholders, as evidenced by the fact that the opportunity cost of capital employed is more than the

  NOPLAT figure. In this example, the management of Intelligent Semiconductor should be considered as

  having failed to provide shareholder value.

  The calculation of Adjusted Operating Profit before Taxes (AOPBT),and Cash Operating Taxes are

  important. The calculation of AOPBT is as follows:

  Operating profit (after depreciation and amortization) + Implied interest on operating leases + any increase

  in the LIFO reserve + goodwill amortization = Adjusted Operating Profit Before Taxes.

  Cash Operating Taxes, another important component of EVA, is calculated as follows:

  Cash Operating Taxes = Income Tax Expense + tax benefit from interest expenses + tax benefit from

  interest on leases + taxes on non-operating income

  Adjusted Operating Profit Before Taxes minus Cash Operating Taxes = Net Operating Profit Less

  Adjusted Taxes (NOPLAT). Subtracting the dollar cost of capital from the NOPLAT figure will yield the

  EVA.